Markets & Finance

Tech Earnings Preview

Many info tech companies will release their quarterly performance reports in the next week. S&P predicts some standouts

For tech investors, the coming week will be chock full of earnings reports. Some of the Standard & Poor's 500-stock index's biggest information technology names will show how they fared in the June quarter—and a number of them could beat consensus estimates, in the view of S&P equity analysts. Investors also will be watching for indications of business activity trends for the remainder of the year, especially now that the U.S. economy is expected to slow down more than S&P previously expected.

S&P Economics is now calling for gross domestic product growth of 2.1% for 2007, down from an earlier forecast of 2.2%. For 2008, the new forecast has been trimmed to 2.7%, from 3.0%.

The tech sector has outperformed the benchmark this year so far, notes Scott Kessler, the information technology group head for S&P Equity Research. As of July 6, the sector has gained 12.3%, above the S&P 500's 7.9% rise. S&P Equity Research recommends market-weighting the sector, which makes up 15.7% of the S&P 500 index.

"Fundamentals Are Fine"

Looking at valuations, the tech sector trades at a higher price-earnings ratio than the benchmark: 21.9 times 2007 forecast earnings, vs. 16.2 for the S&P 500. The p-e-to-growth ratio for the sector is at, or only slightly above, that of the broader S&P indexes (the 500, the Mid-Cap 400, and the Small-Cap 600). Generally, the sector is expected to keep pace with the S&P 500 this year, but S&P thinks that risks remain and carries a neutral fundamental outlook for it.

"The fundamentals are fine and valuations are pretty full. However, seasonality and lofty expectations for the second half are potentially problematic," Kessler explains. "Given notable economic uncertainties, we are focusing on high-quality large caps."

But there still could be some positive surprises next week as companies release their financials, S&P equity analysts believe: "We think companies were probably pretty conservative with June-quarter guidance, which should allow for some upside surprises" from consensus estimates, Kessler says.

S&P equity analyst Zaineb Bokhari, who follows enterprise software, agrees that companies in this group were probably being cautious when providing earnings guidance for the past quarter and that modest upside surprises from consensus estimates are possible. The reason, she says, is with a few exceptions, the second and third quarters are seasonally slower for software firms. That makes for a higher likelihood for business deals to slip or get delayed than during other periods. "Bearing that in mind, and the fact that more companies have seen somewhat slower growth in the U.S., but improving trends in international markets, I think modest upside to consensus estimates are possible," she says.

Storage and Mobile Look Good

Semiconductors have also faced seasonal weakness and could also surprise the Street, according to S&P equity analyst Clyde Montevirgen. Specifically he thinks Intel was probably a bit conservative in its gross margin guidance, "given the competitive pricing environment, various expenses related to technology investments, and inventory burdens." For the industry, Montevirgen sees a few semiconductor companies beating consensus estimates due to stronger-than-expected growth in laptops, certain wireless handsets, digital TVs, and other consumer electronic goods.

Another standout may be SanDisk (SNDK; $52; hold). Unlike other companies within the storage and peripherals industry, this maker of storage products used in popular electronic gadgets has likely benefited from the burgeoning global market for handheld devices, S&P equity analyst Jawahar Hingorani believes. Mobile computing is a continuing trend that may also be cause for higher second-half guidance, he says.

He explains that the drivers are near-term stability in flash pricing and the increased use of types of products it's known for—such as flash memory and cards across most handheld devices—and solid state drives for portable computing, which are being offered as options in high-end laptops. Plus, SanDisk has a very strong retail presence worldwide, he says.

Third-Quarter Results Depend on Consumers

Although S&P is forecasting some upside surprises when companies report the past quarter's results, challenges lie ahead. U.S. consumers are projected to curb spending, which could have implications for companies that market to them. That's what concerns Kessler with regard to eBay.

"EBay is generally pretty conservative with forward guidance, and we expect this to continue, especially given that the third quarter is historically the company's weakest," Kessler says, adding that the company has "become increasingly tied to consumer sentiment and spending." He also notes that eBay's results and guidance might be restrained by the dollar's strength in the second quarter.

Kessler questions the resiliency of the consumer, especially given higher interest rates and commodity prices. "Thus, second-quarter results could be quite good, but investors could be disappointed by forward guidance," he says.